When small businesses need operational capital, the first option that comes to mind is applying for a business loan from a traditional bank.
Much to their disappointment, it can be difficult for small and medium size businesses to meet the lending requirements of a bank and secure funding. Thankfully, traditional banks are no longer the only option small businesses have for obtaining funds.
Alternative lending, which can be defined as any loan obtained outside of a traditional bank or credit union, is an increasingly viable option for small businesses that want to grow and expand without facing the stringent requirements traditional banks may have.
Traditional banks have an established process for lending to corporations, which includes analyzing their track record of success and the financial trajectory of the business.
Small businesses often don’t have the resources to provide the level of data traditional banks want to see. This makes qualifying for and securing funding as an SMB quite difficult, and in many cases, impossible. Small businesses are too important to the economy to suffer a lack of funding, comprising almost all private sector businesses and employing six out of every ten workers in the United States.
Alternative lending is the answer to SMB funding, and these lenders were built to meet the exact needs of smaller businesses excluded by traditional banking requirements. One survey showed alternative lenders approved 71% of loan requests for small businesses vs. only 58% from traditional banks within a year.
In this article we’ll examine every facet of alternative lending, taking a look at what its benefits are, the different types of alternative funding, and how the process differs from traditional lending methods.
The Benefits of Alternative Lending
Alternative lending presents a number of opportunities for small to medium size businesses who have been vastly underserved in the past. In 2018 alone small businesses had unmet funding needs of $5 trillion, pushing them further in their search for alternative funding options.
Digital lenders, who specialize in alternative lending which takes place within an online platform, designed their processes for small businesses, with a solid understanding of their limitations, needs, and preferences.
Turning to alternative lending methods often means funding is:
1. Faster
The traditional process of getting a business loan may involve filling out hours of paperwork and attending a meeting in person at a bank, followed by waiting days or even weeks to find out if you’ve been approved. Digital lending means funding could be secured in just a few hours by exchanging information via an online platform.
2. More Accessible
Remember how banks want to see the data? Traditional funding isn’t easily accessible if you can’t meet the requirements. This disproportionately and adversely affects small businesses. Alternative lending levels the playing field. According to Biz2Credit’s small business lending index, in June 2022 the approval rate of alternative lenders outpaced traditional banks by more than 10%.
3. Less Restricted
Traditional loans are accompanied by stipulations about how the money can be used. On the other hand, alternative lenders rarely have such restrictions unless the loan is specified in its use (such as the case with equipment or inventory financing).
4. Flexible
Small businesses can get the funding amount they need, even in loan amounts that are smaller than what traditional banks might offer. Diverse types of funding are available with more flexible underwriting terms, allowing small businesses to align the type of loan with the financing need they have.
A Typical Alternative Lending Workflow
Most traditional banking institutions rely on highly manual processes within their lending workflow, which mean long wait times to obtain funding.
And although some aspects of the alternative lending process are similar, the experience is altogether different. Most importantly, because it all takes place within an accelerated time table and digital framework.
Alternative lending usually offers a more streamlined lending process, as everything – from application to underwriting – can be done within online platforms.
The alternative lending process can be broken down into these steps:
- Borrower requests funding and submits application online.
- Lender evaluates risk and credit worthiness.
- Underwriting process determines eligibility and lender extends to borrower (often in a matter of hours).
- Loan is issued and funds are distributed.
- Lender services loan throughout the relationship with the borrower, coordinating administrative tasks.
- The loan is repaid and complete.
Alternative Lending Stakeholders
Alternative lenders don’t answer to the same stakeholders as a traditional banking institution.
With the rise of different SaaS lending solutions, such as Onyx IQ, there comes a variety of alternative lending models. Some alternative lenders may not actually originate the loans but instead partner with funders, while others may work with only one financing supplier. This means multiple parties have a vested interest in monitoring lending performance.
Stakeholders may include:
Investors
Perhaps the most common stakeholder that comes to mind in any business, is investors. They are interested in the financial success of the business and desire to get regular, accurate, and timely detailed information on financial performance.
Employees
Employees have a direct stake in the success of an alternative lending business. They’re carrying out the day-to-day operations of the company, and have personal and financial interests in the business.
Creditors
Creditors have a financial interest in the success of lenders as they’re the ones loaning funds. They want to ensure they are paid back within specified terms.
ISO/Brokers
The least familiar of all stakeholders may be an ISO, an Independent Sales Organization, which serves as the middleman between business owners and funding companies. Employees of an ISO are essentially sales representatives, functioning as brokers to facilitate the lending process between the small business and direct funders.
Syndicators
Syndication is a more complex process where multiple lenders can participate in funding by contributing their own capital. A syndicated loan spreads risk as well as financial opportunity, while offering a high degree of flexibility for the borrower.
Providing each stakeholder with customized reporting that includes data relevant to their KPIs requires effective and streamlined collaboration to quickly manage, monitor, optimize, and adapt.
With today’s technological advances, alternative lenders have improved data collection and can access hundreds, or even thousands, of data points from multiple sources for a single borrower. These data points can be segmented for powerful business insights and can foster transparency and visibility for every stakeholder involved. Technology provides a streamlined solution where stakeholders can easily share their insights and conclusions to other invested parties.
Types of Alternative Lending
Within the ecosystem of alternative lending there are a variety of funding options for small businesses. The following are some of the most common types of alternative lending loans.
Term Loans
Business term loans are the most common type of business funding in alternative lending, and perhaps the most straightforward.
A term loan is a lump sum of money borrowed from a lender, featuring a set timeline (also known as the loan term) for repayment, a fixed number of payments, and a fixed or variable interest rate.
These classic small business loans are popular because they can be used for almost any business purpose, from payroll to acquiring a new location, and the repayment periods are flexible, ranging anywhere from a few months (a short-term loan) to more than a decade (long-term loan).
Business Line of Credit
A business line of credit is another popular option in alternative lending, because of its flexibility. Borrowers have the ability to access funds only when needed, rather than taking a lump sum like a traditional term loan would provide.
A business owner can make withdrawals against their account using a business checking account, credit card or a mobile app, as many times as they want, up to the account’s available credit limit. The line of credit is then paid back with interest, resetting the loan amount back to its original value.
A business line of credit is a good option for businesses who have significant seasonal fluctuation, short-term expenses, or need additional cash flow.
Equipment Loan
As its name suggests, an equipment loan is specifically used for the purpose of buying, upgrading, or improving business equipment or machinery. The equipment itself serves as collateral.
Alternative lenders usually finance up to 100% of equipment costs, without utilizing traditional eligibility criteria like credit score.
Invoice Financing (AKA Receivables Financing)
This lending option is one banks won’t typically offer. Unique to alternative lenders, invoice financing (also known as receivables financing) operates with unpaid invoices serving as collateral on the loan. A business receives advanced funds based on outstanding invoices.
An alternative lender will advance capital that is secured by unpaid invoices, usually with terms offering up to 85% of the value of the invoices, with the remainder paid when the customers pay (including fees and interest).
There are several advantages to invoice financing for both the borrower and lender. For the small business borrower, this method is convenient and affordable. It can help boost growth and bridge the gap with customers who take a long time to pay. For the lender, no additional collateral is required and assessing risk is a more straightforward process.
Merchant Cash Advancing
In this financing method, a lender offers a cash advance that is paid back with a percentage of daily credit card transactions. Funds are repaid on a shorter timeline, often on a weekly basis, and the lender charges a portion of sales as well.
This option works best for companies who do a substantial amount of their business through credit card transactions.
Traditional vs. Alternative Lending
Traditional lenders, meaning the local bank or credit union, used to be the only source of loans or credit for any business. Because they held a monopoly within the funding industry, they were allowed to be more selective with whom they wanted to work with.
In general, traditional lenders have a longer application process and a higher level of rejection rates, due to the high costs of processing and originating loans compared to the revenue the institution is capable of generating.
Alternative lenders take a different approach to the application and qualification process. These lenders have more flexibility and a higher acceptance rate, and work via online lending platforms. This means small businesses can gain easier and quicker access to the capital they need.
In a nutshell, traditional lending means:
- Higher application standards
- Lower annual percentage rate
- Long waits for approval and funding
Whereas alternative lending offers:
- More accessible application requirements
- Faster funding
- Better customer support and overall customer experience
- Higher annual percentage rate
The Importance of Technology in Alternative Lending
Alternative lending is filling in the gap for small businesses that are not having their funding needs met by traditional banks. Digital lending is easier, faster, and often more flexible—all these benefits are only possible because of technology.
Alternative lending is agile because it leverages innovative technology to manage workflows and provide actionable insights to stakeholders. With a streamlined online platform, lenders can cut down on costs, as they can allocate resources accurately, minimize bloat, reduce complexity, and increase security.
PwC reinforces the relationship between alternative lending and technology: “A credit assessment framework aided by the requisite analytical capability enables a firm to select the right borrower in the crowd. This is the single most important factor determining the long-term success of a firm and has to be diligently developed.”
Is technology playing an integral role in your alternative lending business? If you’re looking for an agile, digital lending platform to replace your legacy system, be sure to find one with these features:
- Customizable business credit scorecards
- Workflow automation
- Individual stakeholder portals
- A painless, repeatable collections process
- API integrations for complete visibility
Onyx IQ was designed for small business lenders looking to use best-in-class agile technology in one full-service platform. To learn more about what we can do for you, request a demo today or contact us at info@onyxiq.com.
